Are Boards Getting Shareholders Their Money's Worth? - Reinhart ...

Are Boards Getting Shareholders Their Money's Worth? - Reinhart ...

Are Boards Getting Shareholders Their Money's Worth? - Reinhart ...


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The Global M&A Boom Continues: <strong>Are</strong> <strong>Boards</strong> <strong>Getting</strong><br />

<strong>Shareholders</strong> <strong>Their</strong> Money’s <strong>Worth</strong>?<br />

By Keith L. Johnson and Cynthia L. Richson<br />


Mergers and acquisitions are rife with conflicts<br />

of interest. 1 In addition to the divergent interests of<br />

a target company and acquirer, transactions often<br />

involve conflicting motivations between management<br />

and shareholders, advisors and clients, independent<br />

and inside directors, companies and their<br />

various stakeholders, and inside and outside shareholders.<br />

Among a company’s outside shareholders,<br />

there are also likely to be divergent views between<br />

short-term and long-term investors. Even within<br />

individual institutional investor shareholders, there<br />

may be conflicting interests of public and private<br />

equity portfolio managers or between hedge fund<br />

and long-only portfolio managers.<br />

Moreover, investment banks have been the biggest<br />

beneficiaries of the M&A boom with earnings<br />

soaring at the five biggest investment banks. 2<br />

Critics of public companies that go private allege<br />

that some boards of directors may be accepting<br />

deals for reasons other than best-available price and<br />

that corporate executives are being enriched at the<br />

expense of shareholders. Such criticism has resulted<br />

in increased scrutiny of possible conflicts in private<br />

equity transactions. Even the Delaware Chancery<br />

Court has begun to question the effect that management<br />

conflicts of interest have on negotiation and<br />

approval of transactions where public companies<br />

are being taken private. 3<br />

Despite these conflicts, mergers play a critical<br />

role in the allocation of capital in both the U.S.<br />

and Continental Europe. 4 However, with so many<br />

players pursuing competing agendas, it can be easy<br />

to lose sight of the guiding economic goal that<br />

drives merger and acquisition activity—the creation<br />

of sustainable corporate value for shareowners.<br />

Institutional investors can serve a key role in focusing<br />

all of the merger and acquisition players on<br />

the pursuit of sustainable corporate value creation.<br />

Keith L. Johnson heads the Institutional Investor Consulting<br />

Services section at <strong>Reinhart</strong> Boerner Van Deuren sc and Cynthia<br />

L. Richson is the Founder of Richson Consulting Group, llc.<br />

Mr. Johnson formerly was Chief Legal Counsel of the State of<br />

Wisconsin Investment Board (SWIB) and Ms. Richson formerly<br />

was the Corporate Governance Officer for the Ohio Public<br />

Employees Retirement System (OPERS).<br />

Viewing transactions from the perspective of longterm<br />

institutional investors, as fiduciaries with an<br />

obligation to serve the best interests of their ultimate<br />

beneficiaries, can provide a clear path through<br />

this jungle of conflicts.<br />

A recent survey of corporate directors found<br />

that almost 62 percent agreed with the statement,<br />

“On balance, mergers and acquisitions destroy<br />

more value than they create.” 5 There are numerous<br />

examples of mergers that have gone very badly 6<br />

and an aggregate wealth loss of $240 billion for<br />

acquiring firm shareholders from mergers during<br />

1998 to 2001. 7 Institutional investors have been<br />

burned and are becoming more skeptical about<br />

proposed transactions. With the recent growth in<br />

merger and acquisition activity, this skepticism may<br />

be healthy. 8<br />

Role of Institutional Investors<br />

As a group, institutional investors have an overwhelming<br />

financial incentive to promote integrity<br />

of the merger and acquisition process and good<br />

corporate governance is beneficial to both stockholders<br />

and bondholders. 9 They own 59 percent of<br />

United States public company stock. 10 Institutional<br />

investor ownership of the largest companies is even<br />

more concentrated, at 69 percent for the Fortune<br />

1000. Pension funds alone own 28 percent of<br />

United States public equities; mutual funds own 20<br />

percent; insurance companies own 9 percent; and<br />

banks and foundations both own less than two percent<br />

each. In addition, pension fund equity assets<br />

tend to be heavily indexed, with over 41 percent<br />

invested passively in index funds. 11 Ownership of<br />

public companies in the United States tends to be<br />

broadly dispersed.<br />

In Canada, public company ownership is more<br />

concentrated than in the United States. About 75<br />

percent of companies listed on the Toronto Stock<br />

Exchange have a controlling shareholder, which<br />

may be a founding family or an institutional investor.<br />

12 Control is often maintained through issuance<br />

of dual class stock, with the controlling shareholder<br />

owning a substantial block of the voting class. 13<br />

Volume 15, Number 5 25 The Corporate Governance Advisor

Despite these differences, institutional investors<br />

play a determinative role in the system for corporate<br />

acquisitions in both markets.<br />

The interests of different kinds of institutional<br />

investors, however, can vary considerably. Pension<br />

funds, particularly large public pension funds, are<br />

more heavily indexed and universally invested. 14<br />

This broadly exposes them to market developments<br />

over the long term and predisposes pension fund<br />

managers to take an interest in market integrity<br />

issues and sustainability of corporate performance.<br />

Actively managed mutual fund portfolios, on the<br />

other hand, are more likely to trade often, resulting<br />

in average portfolio turnover of holdings of less<br />

than a year. 15 Accordingly, mutual fund managers<br />

often have a shorter-term view, preferring immediate<br />

profits over building long-term corporate<br />

wealth. Some hedge funds that pursue short-term<br />

strategies have similar interests. Investment managers<br />

that short stock as part of their investment<br />

strategy may even have a vested interest in seeing<br />

declining company fortunes. 16<br />

The impact of these diverging interests was<br />

born out in a 2006 study by Lily Qiu at Brown<br />

University. 17 She reported that acquirers with large<br />

public pension fund shareholders performed relatively<br />

better in the long run than other acquirers<br />

and had fewer value destroying acquisitions. She<br />

also found that mutual fund ownership was positively<br />

associated with future merger and acquisition<br />

activity, and that acquirers with more mutual fund<br />

ownership performed worse in the stock market. 18<br />

Private equity funds are also having an increased<br />

impact on merger and acquisition activity. With<br />

larger amounts of institutional investor money<br />

being allocated to private equity, the number of<br />

companies being taken private in management<br />

buyout transactions bankrolled by private equity<br />

and hedge funds has mushroomed. 19 One of the<br />

results of this “going private” trend has been to<br />

move increases in value achieved in corporate turnarounds<br />

from public to private market investors. 20<br />

Even for institutional investors that participate in<br />

management buyouts through private equity funds,<br />

the net effect of transferring gains to private market<br />

portfolios may not offset the corresponding<br />

losses to the institutional investor’s public portfolios<br />

(including combined index fund and passively<br />

managed portfolio exposure). 21<br />

In response, some public market investors have<br />

begun to fight back against management buyouts. 22<br />

<strong>Shareholders</strong> filed a lawsuit in New York City in<br />

November 2006 alleging that 13 private equity firms<br />

conspired to fix buyout prices by bidding collusively<br />

in transactions involving three public companies. 23<br />

A related United States Justice Department investigation<br />

is also pending.<br />

Institutional Investor Issues in<br />

Mergers and Acquisitions<br />

The varying interests of institutional investors<br />

result in different views on issues that arise in merger<br />

and acquisition transactions. Understanding these<br />

differences between investors presents both challenges<br />

and opportunities to other transaction participants.<br />

Hot button issues can include the following:<br />

(1) Short-term gains versus sustainable longterm<br />

wealth : Although pension funds and most<br />

of the investors in mutual funds are investing to<br />

meet long term goals, many of the portfolio managers<br />

that serve as the stewards of their assets<br />

operate with a short-term investment horizon that<br />

is driven by competitive pressures. In both the<br />

United States and Canada, pension funds control<br />

more wealth than any of the other institutional<br />

investors. However, many pension fund managers<br />

delegate investment responsibility for large chunks<br />

of those assets to external investment firms, which<br />

are then evaluated on a quarterly basis and paid on<br />

assets under management rather than performance<br />

over any particular time period. This can result in<br />

a disconnect between the long-term interests of<br />

underlying investors and the strategies of portfolio<br />

managers.<br />

Short-term investors are more likely to support<br />

merger and acquisition strategies that emphasize the<br />

creation of immediate gains, even at the expense of<br />

a company’s future health. However, investors that<br />

take a truly long-term view are likely to be more<br />

open to considering the impact of a transaction on<br />

sustainability of performance and support strategic<br />

plans that will build company value over several<br />

years. Where there is a tension between the shortterm<br />

and long-term impact of a transaction, many<br />

institutional investors will want to evaluate how it<br />

fits with their investment horizon. For example, risks<br />

relating to company reputation, future regulatory<br />

changes and product obsolescence may be of more<br />

The Corporate Governance Advisor 26 September/October 2007

concern to long-term investors, particularly those<br />

with index fund exposure to the company. 24<br />

<strong>Boards</strong> have been accorded wide business judgment<br />

discretion to determine when a company<br />

should pursue long-term strategic business goals<br />

over maximization of short-term returns. 25 They<br />

can use this discretion to align with long-term investors<br />

in pursuing strategic plans to create sustainable<br />

corporate wealth. However, when communicating<br />

about strategic plans with portfolio staff at institutional<br />

investors, companies might need to stress<br />

this fundamental alignment of long-term interests<br />

between the company and the institutional investor’s<br />

clients or beneficiaries.<br />

(2) Alignment of Executive Compensation with<br />

Investor Interests : While change in control payments<br />

were originally intended to remove any disincentive<br />

for target company executives to oppose a transaction<br />

that could cost them their jobs, the payments<br />

have become large enough at many companies to<br />

create an economic incentive for executives to support<br />

a transaction regardless of whether it is in the<br />

best interests of shareholders. In addition, where<br />

executives will receive other compensation from<br />

the acquirer or accelerated vesting of options in<br />

connection with the transaction, change in control<br />

payments may be unnecessary. At their worst, these<br />

payments can add up to huge amounts that appear<br />

to be an inappropriate reward for the company’s<br />

underperformance that lead to the transaction.<br />

In addition, studies have found that the amount<br />

of compensation an executive receives is mostly<br />

related to size of the company. 26 This creates an<br />

incentive for executives of acquiring companies<br />

to undertake acquisitions merely to obtain an<br />

increased compensation award—a disastrous combination<br />

for shareholders when combined with the<br />

poor track record for acquisitions.<br />

Management buyouts can also present the opportunity<br />

for misalignment in payments to executives.<br />

Private equity firms can often offer the executives<br />

added bonuses and options in the new company,<br />

which may not be publicly reported until long after<br />

the transaction has been completed, if ever. 27 The<br />

use of substantial private payments to a company’s<br />

executives in a going-private transaction raises<br />

questions about whether the executives were essentially<br />

“bought off.” 28 In two June 2007 decisions,<br />

the Delaware Chancery Court even temporarily<br />

enjoined acquisitions of Lear Corporation and The<br />

Topps Company because public shareholders were<br />

not informed of the role that personal financial<br />

interests of management at the companies might<br />

have played in favoring private acquisitions. 29<br />

In addition, research indicates that company management,<br />

preceding a management buyout, tends to<br />

record lower than expected accounts receivable and<br />

otherwise engage in financial manipulation to make<br />

company performance look worse. 30 Public shareholders<br />

bear the brunt of these shenanigans.<br />

Companies would be well-served to make any<br />

change in control payments subject to approval by<br />

the shareholders. 31 Greater and more timely transparency<br />

would also help to eliminate (or confirm)<br />

suspicions about the size and extent of executive<br />

compensation related to a proposed change in<br />

control. 32 <strong>Boards</strong> should make sure they are aware<br />

how large total change in control payments could<br />

be, well in advance of any transaction, in case they<br />

need to be revised. Excessive golden parachute<br />

payments, cash out of options, tax gross ups,<br />

forgiveness of corporate loans, unearned retirement<br />

program contributions and compensation<br />

that rewards poor performance are particularly<br />

objectionable to investors.<br />

(3) Independent Committees and Independent<br />

Advisors : Inside directors, investment banks, compensation<br />

consultants and other advisors involved<br />

in transactions often have conflicts of interest. For<br />

example, payment of a success fee or use of “stapled”<br />

financing where the investment bank advising<br />

the target also provides financing to the acquirer,<br />

gives the investment bank a financial interest in<br />

ensuring success of the transaction. The prospect<br />

of future business from a serial acquirer or private<br />

equity fund could also bias an investment bank<br />

toward ensuring a transaction closes. Fairness opinions<br />

from investment banks with a vested interest in<br />

the transaction are loaded with litigation risk. 33 In<br />

addition, use of compensation consultants that also<br />

do significant work for management could result in<br />

the board receiving biased advice.<br />

<strong>Boards</strong> could do a better job separating good<br />

from bad acquisitions by making more effective use<br />

of independent board committees and by retaining<br />

independent advisors to review the transaction.<br />

While inside directors may balk at the idea, the<br />

practice is becoming more prevalent. In a recent<br />

Volume 15, Number 5 27 The Corporate Governance Advisor

survey of corporate directors, 30 percent said that<br />

they always engage independent board advisors<br />

when contemplating a purchase or sale. 34 An additional<br />

32 percent said that they “sometimes” engage<br />

an independent board merger and acquisition advisor.<br />

35 Fifty four percent of the director respondents<br />

reported having voted down or materially changing<br />

a contemplated transaction.<br />

Retention by the board of an independent investment<br />

banking firm with specialized industry knowledge<br />

can bring a fresh view to evaluation of a<br />

transaction and even identify alternatives. In order<br />

to be truly independent, the firm cannot be paid an<br />

incentive or success fee. Directors could also limit<br />

their legal exposure and the company’s downside<br />

risk by obtaining a (second, if necessary) fairness<br />

opinion from an independent valuation firm. 36 The<br />

board should not place restrictions on the fairness<br />

evaluation (such as unrealistic assumptions) that<br />

will reduce its reliability.<br />

Finally, the success of a merger or acquisition<br />

does not depend solely on making the right decision<br />

up front. Integration planning and implementation<br />

are just as critical. Failure to address<br />

cultural differences and poor strategic planning or<br />

implementation are often cited as common reasons<br />

why business combinations fail. The board’s duties<br />

do not stop once a transaction has been closed. In<br />

fact, companies might want to consider deferring a<br />

portion of the fee of key advisors until integration<br />

plans have been executed. This would move the<br />

focus toward delivery on the promises cited when<br />

the deal was proposed and align advisors with longterm<br />

shareholders. Disclosure of the company’s<br />

advisors’ long-term merger and acquisition success<br />

rate in previous transactions would also be helpful<br />

to both the board and shareholders. 37<br />

(4) Corporate Governance Issues : The quality<br />

of a company’s corporate governance will often be<br />

evident in the way it approaches a potential transaction.<br />

<strong>Shareholders</strong> and their advisors will be<br />

evaluating the strategic rationale, process fairness,<br />

valuation decisions, conflicts of interest, executive<br />

compensation, use of takeover defenses and company<br />

governance profile to determine the quality<br />

of the company’s corporate governance. This will<br />

be an ongoing process that is done on a case-bycase<br />

basis. Proxy voting consultants usually play<br />

a key role in advising shareholders on transactions<br />

that require a shareholder vote, though<br />

their recommendations may not be determinative<br />

for sophisticated institutional investors that make<br />

their own decisions on merger and acquisition<br />

transactions. Ultimately, shareholders will take<br />

corporate governance into consideration as one of<br />

the factors that are weighed when making a vote or<br />

tender decision. 38<br />

The more confidence shareholders have that<br />

a company’s board is aligned with the interests<br />

of its owners, functioning independent of management<br />

and acting in the shareholders’ best<br />

interests, the more likely shareholders will defer<br />

to the board’s recommendation. Clear communication<br />

with shareholders and their advisors is<br />

vitally important to establishing and maintaining<br />

this kind of trust. It is important that companies<br />

identify where, within the management structure<br />

of their large institutional shareholders, the final<br />

decision will be made on a vote or tender offer and<br />

engage with that part of the organization directly<br />

when issues arise. 39<br />

The following are among the corporate governance<br />

concerns that shareholders assess when considering<br />

whether a board is likely to act in the best<br />

interests of long-term shareholders when evaluating<br />

acquisitions:<br />

• <strong>Are</strong> anti-takeover devices structured to insulate<br />

management or are they subject to shareholder<br />

approval?<br />

• Does the company have a strongly independent<br />

board or is the board controlled by management?<br />

• Is there a classified board structure that makes it<br />

difficult to change the board?<br />

• Has the company adopted a requirement that<br />

directors receive a majority of the votes cast in<br />

order to be elected?<br />

• Is there a supermajority voting requirement for<br />

approval of takeovers that allows minority or<br />

inside shareholders to block transactions?<br />

• If the CEO is also Board Chair, is there an effective<br />

and independent lead director?<br />

• Do the directors have individually significant<br />

holdings of company equity to align their interests<br />

with shareholders?<br />

The Corporate Governance Advisor 28 September/October 2007

• <strong>Are</strong> excessive change in control or other gratuitous<br />

executive compensation payment provisions<br />

in place?<br />

• <strong>Are</strong> executive compensation practices inconsistent<br />

with “pay for performance” principles, such<br />

that it appears the board has been captured by<br />

management or that management incentives are<br />

misaligned with shareholders?<br />

• Have independent advisors been retained to<br />

assist an independent committee of the board in<br />

evaluating the transaction?<br />

• <strong>Are</strong> success fee payments or other advisor conflicts<br />

of interest present in the transaction?<br />

• Does the company have a history of successful<br />

mergers and acquisitions?<br />

• What is the company’s corporate governance<br />

rating and what do the rating firms view as the<br />

company’s governance weaknesses? 40<br />

• Emerging Trends : Private equity deals have<br />

accounted for more than a third of all merger<br />

activity this year and 40 percent of US M&A<br />

activity this quarter, the highest level ever. 41<br />

Private equity is reshaping the public markets<br />

with new trends such as “stub equity” where<br />

public shareholders can exchange some of their<br />

shares for securities in the new, privately owned<br />

company. 42<br />

Stub equity deals, such as the buyout of Harman<br />

International Industries Inc. by Kohlberg, Kravis,<br />

Roberts & Company (KKR) and Goldman Sachs<br />

Group Inc., have allowed public equity holders<br />

to participate in the upside value inherent in their<br />

equity. However, stub equity typically provides no<br />

shareholder rights to holders and leaves them at<br />

the mercy of the company’s new private equity firm<br />

managers.<br />

In addition, private equity firms such as<br />

Blackstone and KKR are raising money through<br />

initial public offerings of their management subsidiaries,<br />

without making the public disclosures the<br />

Securities and Exchange Commission requires of<br />

Registered Investment Advisors—a feat described<br />

by some as cracking the code on how to function as<br />

a private company in the clothing of a public company.<br />

43 Such structures leave shareholders of the<br />

private equity management companies with little<br />

information and virtually no say in the company’s<br />

management or investment decisions. 44 The funds<br />

generated through these offerings also provide the<br />

private equity firms with additional capital that is<br />

controlled by the managers.<br />

This creation of stub equity holders and private<br />

equity management firm shareholders, both with<br />

economic interests but virtually no governance<br />

rights, provides potential economic advantages for<br />

them while creating new agency risks from the inherent<br />

conflicts of interest they have with the private<br />

equity firm managers. Will the private equity firm<br />

managers find ways to divert value away from stub<br />

equity holders through generation of additional<br />

fees that are paid by the underlying companies to<br />

the management firms? Will they frustrate stub<br />

holders by engaging in balance sheet structuring<br />

that steers earnings away from equity?<br />

One thing is certain, this new private equity<br />

environment will place even more pressure on public<br />

company boards to protect their shareholders<br />

from being taken advantage of in going-private<br />

transactions.<br />

Conclusion<br />

<strong>Boards</strong> need to be keenly aware of the divergent<br />

interests of different shareholders. They are charged<br />

with balancing those interests in pursuing the<br />

creation of sustainable corporate wealth. Current<br />

evidence suggests that companies have generally not<br />

done a good job in handling mergers and acquisitions.<br />

However, by proactively seeking to develop a<br />

long-term shareholder base, addressing conflicts of<br />

interest, aligning executive compensation incentives<br />

with shareholders and adopting corporate governance<br />

best practices, boards could improve their<br />

merger and acquisition track record. Company<br />

advisors and consultants could also be more effective<br />

in helping to identify transactions that will<br />

build sustainable value.<br />

Notes<br />

1. Robert Kindler, Vice Chairman for Investment Banking<br />

at Morgan Stanley recently said on a panel at the Corporate<br />

Law Institute at Tulane University, “We are all totally conflicted—get<br />

used to it.” Morgan Stanley advised the Tribune’s<br />

special committee of independent directors in the recent sale of<br />

Volume 15, Number 5 29 The Corporate Governance Advisor

the company. Stuart Goldenberg, “When a Bank Works Both<br />

Sides,” The New York Times, April 8, 2007.<br />

2. Net income in the past 12 months at the five largest<br />

investment banks has skyrocketed: Goldman Sachs: 56%,<br />

Morgan Stanley: 68%, Merrill Lynch: 110%, Lehman Bros.:<br />

17%; and Bear Sterns: 31%. John Waggoner, “Investment<br />

Banks Benefit Most from M&A Mania,” USA Today, May<br />

25, 2007.<br />

3. Peter Lattman and Dana Cimilluca, “Court Faults Buyouts,”<br />

The Wall Street Journal, July 12, 2007, citing temporary injunctions<br />

issued by the Delaware Chancery Court in acquisitions<br />

of Lear Corporation and The Topps Company due, in part, to<br />

undisclosed compensation arrangements of private acquirers<br />

with the management of public companies.<br />

4. For the first time, Continental European firms were as<br />

eager to participate as their U.S. and U.K. counterparts in<br />

the fifth M&A wave during the 1990s and M&A activity since<br />

January 1, 2007 is 63% higher than in 2006 on track to set<br />

another record. Mergers and Acquisitions in Europe, Marina<br />

Martynova and Luc Rennenboog, January 2006, SSRN.com;<br />

and “Huge deals fuel record-breaking M&A,” Financial Times.<br />

com, May 7, 2007.<br />

5. Directors and <strong>Boards</strong>, August Question of the Month, http://<br />

www.directorsandboards,com/debriefing/September2006/<br />

qomaugust2006.html (visited September 5, 2006).<br />

6. For example, Robert F. Bruner, in his book “Deals from<br />

Hell,” cites the AOL Time Warner merger as a champion of<br />

failed mergers, ultimately resulting in a US$200 billion loss<br />

in stock market value and a US$54 billion write-down in the<br />

combined company’s assets.<br />

7. “Institutional Investors’ Trading Behavior in Mergers<br />

and Acquisitions, Rasha Ashraf and Narayanan Jayaraman,<br />

Georgia Institute of Technology, March 27, 2007, available at<br />

SSRN.com.<br />

8 The volume of mergers and acquisitions during the first<br />

nine months of 2006 was at a record US$2.7 trillion. Lina<br />

Saigol and James Politi, “Rise in Hostile Bids Pushes M&A to<br />

Record,” Financial Times, September 29, 2006. According to<br />

Thompson Financial, from 2005 through July 13, 2007 there<br />

have been 1,287 levereged buyouts with a total value of $787<br />

billion. Michael J. de la Merced, “An I.P.O. Glut just Waiting<br />

to Happen,” The New York Times, July 15, 2007.<br />

9. The Impact of Shareholder Power on Bondholders:<br />

Evidence from Mergers and Acquisitions, Angie Low, Anil<br />

K. Makhija, and Anthony Sanders, March 1, 2007, SSRN.<br />

com.<br />

10. The Conference Board, “Institutional Investment Report<br />

2005,” citing ownership as of 2003.<br />

11. Id.<br />

12. Aviv Pichhadze, “Mergers, Acquisitions and Controlling<br />

<strong>Shareholders</strong>: Canada and Germany Compared,” 18 Banking<br />

and Finance Law Review 341 (June 2003).<br />

13. Id.<br />

14. The Conference Board, “Report of the Commission on<br />

Public Trust and Private Enterprise,” January 2003.<br />

15. Id.<br />

16. A recent study by Bernard Black and Henry Hu documented<br />

a number of instances where hedge funds and other<br />

investors have used swaps, short sales, derivatives, borrowed<br />

stock, hedging and other techniques to acquire voting rights<br />

on acquisitions in which they held no overall economic interest.<br />

The shares were then voted without regard to whether they<br />

believed the transaction would benefit the company. Henry<br />

T. C. Hu and Bernard Black, “The New Vote Buying: Empty<br />

Voting and Hidden (Morphable) Ownership” 79 Southern<br />

California Law Review 811 (2006).<br />

17. Lily Qui, “Which Institutional Investors Monitor? Evidence<br />

from Acquisition Activity,” http://www.econ.brown.edu/fac/lily_qiu<br />

(visited August 13, 2006).<br />

18. Id. A one percent increase in mutual fund ownership was<br />

found to be associated with a reduction of six to 131 basis<br />

points in various 12-month returns, including the transaction<br />

announcement month.<br />

19. Allocation of assets by the top 200 pension funds grew by<br />

14 percent in 2005, to US$97 billion, while allocations to hedge<br />

funds grew 42 percent, to US$30 billion but still amounts to<br />

only about five percent of assets. Pensions & Investments,<br />

January 23, 2006. The number of private buyouts announced<br />

for European companies increased by 320 percent between<br />

2001 and 2005. Jason Singer, “In Twist for Private Buyouts,<br />

Some <strong>Shareholders</strong> Fight Back,” Wall Street Journal, August<br />

18, 2006. Private equity deals in the United States are on<br />

track to be twice the value in 2006 than they were in 2005.<br />

Anna Driver, “Holders Sue Private Equity Firms Over Deals,”<br />

Reuters News Service, November 15, 2006.<br />

20. For example, the Blackstone Group took Celanese private<br />

in December 2003 in a deal it valued at US$4 billion. One year<br />

later, it was sold back to public investors for US$6.5 billion, with<br />

virtually no changes other than shifting its stock market listing<br />

the United States. Breaking Views, “On Going Private: Investors<br />

Beware,” Wall Street Journal, November 18–19, 2006.<br />

21. For example, where an institutional investor has combined<br />

passive and active portfolio holdings that total four percent of a<br />

company’s public equity and ends up with a four percent stake in<br />

the private equity fund, it is likely that the investor will have lost<br />

at least 20 percent of it’s equity stake in the company to private<br />

equity fund fees and management’s carried interest. If the company<br />

could have been turned around as a public company, the<br />

investor has essentially benefited the private equity fund managers<br />

and company executives at the expense of its own investors<br />

or beneficiaries. However, this loss will be largely invisible if<br />

the investor measures its performance against an index-relative<br />

benchmark. The investor’s private equity portfolio managers will<br />

obtain a nice return, and the public equity portfolio managers<br />

will not be aware of the returns that were transferred elsewhere.<br />

22. Several large investors, including Knight Vinke Asset<br />

Management, fought the sale of VNU to a group of private<br />

equity firms last summer, arguing that the small premium being<br />

offered did not merit leaving the rich profits on the table that<br />

the private equity investors would reap from quickly restructuring<br />

VNU. While the transaction eventually went through, the<br />

shareholders did win an increase in the purchase price. Jason<br />

Singer, “In Twist for Private Buyouts, Some <strong>Shareholders</strong> Fight<br />

Back,” Wall Street Journal, August 18, 2006.<br />

23. Company transactions involved in the lawsuit are Univision<br />

Communications, HCA Inc. and Harrah’s Entertainment.<br />

The Corporate Governance Advisor 30 September/October 2007

24. Companies with long-term strategies might also want to<br />

undertake proactive efforts to establish a base of shareholders<br />

inclined to take a long-term view. This is one of the recommendations<br />

in the “Report of the Commission on Public Trust and<br />

Private Enterprise” issued by The Conference Board, January<br />

2003.<br />

25. In Unocal Corp v. Mesa Petroleum Co., 493 A.2d 946 (Del.<br />

1985) the Delaware Supreme Court said that boards could<br />

consider the disparate interests of short-term speculators and<br />

long-term investors and authorized boards to even favor longterm<br />

investors over shareholders who wanted a quick profit.<br />

However, once a board has decided to sell control of a company,<br />

they have an obligation to serve as auctioneers and get<br />

the best price for shareholders. See Revlon, Inc. v. MacAndrews<br />

& Forbes Holdings, Inc., 506 A.2d 173 (Del. 1985).<br />

26. Lucian Arye Bebchuk and Yaniv Grinstein, “Firm<br />

Expansion and CEO Pay” (November 2005). Harvard Law<br />

and Economics Discussion Paper No. 533. Available at SSRN:<br />

http://ssrn.com/abstract=838245.<br />

27. For example, in the Celanese management buyout, the<br />

company’s executives are reported to have received optionrelated<br />

compensation that was worth US$65 million when the<br />

company went public again, on top of salaries and bonuses.<br />

Breaking Views, “On Going Private: Investors Beware,” Wall<br />

Street Journal, November 18–19, 2006. In addition, the AFL-<br />

CIO recently challenged the proposed IPO of the Blackstone<br />

Group and the private equity firm’s claim that it is not an<br />

investment company so it can sell its shares to the public<br />

without being regulated by the Securities and Exchange<br />

Commission under the Investment Company Act of 1940.<br />

“Union Takes Aim at Blackstone I.P.O.,” The New York Times,<br />

Dealbook, May 16, 2007.<br />

28. The California Public Employees Retirement System recently<br />

opposed a merger of United Health Group with PacifiCare<br />

Health Systems unless the companies held a shareholder vote<br />

on proposed executive bonuses to be paid in the transaction.<br />

In 2005, Molson reduced change in control payments to satisfy<br />

shareholders before its merger with Adolph Coors.<br />

29. After listing the financial advantages offered to management<br />

by a private acquirer, the Delaware Chancery Court<br />

concluded, “Put simply, a reasonable stockholder would want<br />

to know an important economic motivation of the negotiator<br />

singularly employed by a board to obtain the best price for the<br />

stockholders, when that motivation could rationally lead that<br />

negotiator to favor a deal at a less than optimal price, because<br />

the procession of a deal was more important to him, given his<br />

overall economic interest, than only doing a deal at the right<br />

price.” In Re: Lear Corporation Shareholder Litigation, C.A.<br />

No. 2728-VCS (June 15, 2007). The deal was subsequently<br />

rejected by Lear shareholders. See also In Re: The Topps<br />

Company <strong>Shareholders</strong> Litigation, C.A. No. 2786- VCS (June<br />

14, 2007).<br />

30. Carol A. Marquardt and Christine I. Wiedman, “How are<br />

Earnings Managed? An Examination of Specific Accruals,”<br />

Contemporary Accounting Research, Vol. 21, No. 2, Summer<br />

2004.<br />

31. On April 20, 2007, the U.S. House of Representatives<br />

passed “The Shareholder Vote on Executive Compensation<br />

Act” by a vote of 269–134., which is also applicable to merger<br />

and acquisition transactions. http://financial services.house.<br />

gov/ExecutiveCompensation.html. The bill will move next to the<br />

Senate Banking Committee.<br />

32. In management buyout situations, outside shareholders<br />

would benefit from obtaining full knowledge of all consideration<br />

that is or will be paid to management. The conflicts of<br />

interest associated with management participation in a buyout<br />

from outside shareholders are especially troublesome.<br />

33. The National Association of Securities Dealers has been<br />

investigating concerns about conflicts of interest in the issuance<br />

of fairness opinions. It has proposed a disclosure-based<br />

approach to highlighting conflicts which many view as inadequate<br />

to address the fundamental flaws associated with using<br />

conflicted financial advisors. Federal Register, Vol. 71, No. 69,<br />

April 11, 2006.<br />

34. Directors & <strong>Boards</strong>, “The Directors & <strong>Boards</strong> Survey:<br />

Mergers & Acquisitions,” Boardroom Briefing, Fall 2006.<br />

35. Id. The most common independent advisors directors<br />

reported using were the board’s law firm (31 percent), the<br />

board’s own M&A firm (27 percent) and the board’s accounting<br />

firm (27 percent).<br />

36. For example, recent deals where independent fairness opinions<br />

were obtained include sales of May Department Stores,<br />

Albertsons, Constellation Energy, Sungard Date Systems,<br />

Dex Media and Texas Instruments’ sensors and controls business.<br />

See Jeffrey Williams, “What Directors Need to Know<br />

About Fairness Opinions,” Boardroom Briefing: Mergers &<br />

Acquisitions, Directors & <strong>Boards</strong>, Fall 2006.<br />

37. An analysis done for the New York Times by Capital IQ,<br />

a business unit of Standard & Poors, shows that the track<br />

record for buyer performance after a major acquisition varies<br />

substantially between investment banks involved in advising<br />

buyers. “ They’re All No. 1, but <strong>Are</strong> They <strong>Worth</strong> It?” The New<br />

York Times, Dealbook, August 5, 2007.<br />

38. Institutional investors that are not happy with a proposed<br />

transaction may publicly oppose it. For example, the California<br />

Public Employees Retirement System recently opposed a merger<br />

of United Health Group with PacifiCare Health Systems<br />

because of executive bonuses to be paid in the transaction.<br />

39. Some institutional investors will delegate responsibility to<br />

their external investment managers and some will retain final<br />

authority, with decisions made by the chief investment officer,<br />

portfolio manager, proxy voting administrator or other officer.<br />

40. Several shareholder advisory firms (e.g., Institutional<br />

Shareholder Services, Governance Metrics International and<br />

The Corporate Library) evaluate and rate companies on their<br />

corporate governance.<br />

41. Dana Cimilluca, “Private Equity Fuels Record Merger<br />

Run,” Wall Street Journal, July 20, 2007.<br />

42. Dennis Berman, “Unusual Buyout Offers a Piece to<br />

<strong>Shareholders</strong>,” Wall Street Journal, April 27, 2007.<br />

43. Henry Sender and Monica Langley, “How Blackstone’s<br />

Chief Became $7 Billion Man,” Wall Street Journal, June 13,<br />

2007.<br />

44. Dennis Berman, “Latest Trend in Big Buyouts: Blend of<br />

Public, Private Traits,” Wall Street Journal, May 22, 2007.<br />

Volume 15, Number 5 31 The Corporate Governance Advisor

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